Why might subsidies for positive externalities lead to inefficiency if overused?

• A. Subsidies always improve welfare.
• B. Subsidies reduce deadweight loss and misallocation.
• C. Subsidies can overproduce the good, causing DWL and misallocation if not targeted properly.
• D. Subsidies only affect government revenue.

Answer: (C)

Positive externalities mean the total benefit to society from a unit of the good is larger than the private benefit individuals consider. The efficient outcome is where social marginal benefit equals social marginal cost. A per-unit subsidy lowers the private cost or raises private benefit, shifting incentives to produce or consume more of the good. If the subsidy is correctly sized, it can move output toward the socially optimal level.

But if subsidies are overused or poorly targeted, they can push production beyond the point where total social benefit justifies the cost. The extra units give little additional benefit to society while consuming resources and imposing costs on taxpayers. That creates deadweight loss and a misallocation of resources, meaning the economy ends up less efficient overall. Subsidies won’t always improve welfare, and they affect more than government revenue—they influence prices, quantities, and welfare across buyers and sellers.

That’s why the best answer is that subsidies can overproduce the good, causing deadweight loss and misallocation if not targeted properly.